Will we see more easing from the Bank of Japan?

As we head into the coming policy meeting on 28-29 July, there are buoyant expectations that the BoJ will add stimulus measures to the current mix.

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IG Analyst

2016-07-25T11:41:33+0100

Source: Bloomberg

A policy board member at the Bank of Japan (BoJ) opined during the June policy meeting that ‘policy decisions that intend to surprise the market are likely to reduce the predictability of monetary policy significantly, and thereby lessen policy effects through higher volatility in the market.’

It is amusing given that the BoJ has a history of surprising the financial markets with policy moves and FX intervention. The Bank unexpectedly delved into negative interest rate policy in late January, in a bold move to stimulate the Japanese economy amid volatile market conditions. It was a narrow 5-4 vote to charge a 0.1% interest on a portion of current account deposits that financial institutions place with the central bank. Consequentially, surprised market participants reacted by bidding up global equities and sovereign bonds while selling the yen.

Markets see further easing

As we head into the coming policy meeting on 28-29 July, there are buoyant expectations that the BoJ will add stimulus measures to the current mix. The only problem is which measures they will pump up or all of them. The idea of helicopter money was floated in the media, former Fed chairman Ben Bernanke’s visit to Japan stoked intense speculation that Japan’s PM Abe may resort to using a direct and one-off capital infusion via the BoJ. This was dismissed by BoJ governor Kuroda in a radio interview with the BBC taped in June. Kuroda said there was no significant limitations to current monetary easing conditions, stressing that they still have the three options – quantitative, qualitative and negative interest rates - to ease further if necessary.

The Japanese economy continues to face significant growth headwinds, with weakness in private consumption, as well as the adverse impact of a stronger yen. Weakened inflation expectations, and the view that prices are likely to stay low for the time being, fuelled prospects of more stimulus from the central bank.

Total

Unchanged at 80

Increase to 90

Increase to 100

QQE

40

23

9

6

Unchanged at -0.1%

Cut to -0.2%

Cut to -0.3%

Policy Rate

40

20

11

9

Source: Bloomberg

The consensus is for the BoJ to cut the policy rate deeper by 5 basis points to -0.15% from -0.10%. Some analysts forecasted up to a 20 basis-point cut. The annual asset purchases under the Quantitative and Quality Easing (QQE) programme should remain at ¥80 trillion, although there are analysts who predicted increases of ¥10-20 trillion. Overall, the varied predictions mean that the policy decision will be a close call.

Those calling for more easing argued that softening inflationary pressures warrant more aggressive action. The BoJ’s preferred inflation gauge, core CPI less 2014 sales tax hike, showed that core inflation decelerated to 0.8% in May from 1.3% in December 2015. This suggested that we are moving away from the price stability target of 2%. In other words, more easing may be necessary to encourage more inflation.

BoJ should keep a steady ship

However, there are few signs that the situation is going to get considerably worse. One of the reasons the BoJ left policy unchanged in June was because of uncertainty arising from the UK referendum on the EU membership. While the impact of the Brexit vote on global economies and financial markets is far from being clear, the resilience displayed has delayed the need for a coordinated response from global central banks. They are perfectly fine with a wait-and-see approach. The Bank of England (BoE) and the European Central Bank (ECB) maintained monetary settings, with expectations for the FOMC to do the same this week.

To be sure, the BoJ reiterated that it would consider additional monetary easing measures if needed to stabilise the economy and achieve the price stability target. However, they are also pretty sanguine about Japan’s growth outlook. In June, they said that Japan’s economy kept on a moderate recovery trend, helped by an improvement in the employment and wage situation. They also think that prices and inflation expectations will gradually pick up in the latter half (Sep 2016 – Mar 2017) of fiscal 2017, on the back of a tight labour market and rising business fixed investment.

Furthermore, some BoJ members highlighted that the effect of the negative interest rate policy is starting to spread to the real economy. Not only are sovereign bond yields lower or negative, lending rates and issuing rates on corporate bonds have also significantly declined. The number of housing starts has accelerated, thanks to a fall in mortgage rates. As an aside, the BoJ cautioned that it is necessary to monitor the sharp increase in lending to the real estate sector.

In addition, Abe’s decisive win in the upper house elections in July, prompted him to pledge a bold move to the first arrow of Abenomics – fiscal spending. It is reported that the size of the proposed stimulus package could be between ¥20 trillion and ¥ 30 trillion, twice or thrice the initial ¥10 trillion mooted earlier.

Scope for disappointment may raise market volatility

I would think that it is prudent for BoJ to continue assessing the situation before making further adjustments to policy settings. However, anticipation about both BoJ action and fiscal stimulus has lifted risk appetite in recent weeks. The Japanese yen has weakened for the last two weeks. Since surging to around 100 per USD, the JPY has depreciated over 5%. The Nikkei 225 soared over 10%, adding over 1500 points from around 15,000.

This implies that there is potential for disappointment if BoJ does nothing this Friday. And the result of this disappointment will be a quick unwinding of stimulus trades. Yen could strengthen markedly while Japanese equities and JGBs should see strong selling pressure.

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